The big difference is that NNWC looks purely at liquid and tangible asset value. It doesn’t include any prepaid expenses or even deferred taxes that NCAV does include.

Accounts receivables are marked down for doubtful accounts and inventory gets a 50% off haircut and to reflect a rapid fire sale.

When Circuit City was going through its liquidation, they didn’t try to sell what they had left at 10% or even 20% off.

Prices were marked 50% and more because it just had to be cleared.

The key distinction however is that liquidations are very rare in the market. There are a lot of costs associated with liquidating and it takes a long time to fully unwind.

So NNWC is more of a theoretical number to help you see how conservative the valuation is.

Why You Would Buy a Net Net

Why You Should Care About Net Nets

Knowing how to calculate NCAV and NNWC is all well and good, but what’s the point?

If a stock is priced for liquidation, why even bother buying it?

Well, here are some reasons why I buy net net stocks.

Very easy to value

There is a solid floor

Most are simple businesses to understand

Nobody wants it

Small to micro caps usually

Low volume

I’m not talking about just any net net stock though. A net net has to pass a set of criteria before I buy it.

But I love the fact that it is so black and white.

Assuming you found a good one, your downside is protected by the liquid assets and you are buying with a huge margin of safety.

If the company has other long term assets like buildings or cash overseas, that’s an included bonus if it can get unlocked.

It’s such a rare strategy where you don’t even have to know much about the industry or the future.

You can just focus on the individual business and that’s it.

And because it’s so simple, people stay away from it.

When I purchased Friedman Industries (FRD), it wasn’t a net net at the time, but the downside was well protected with a NCAV of $7.29 per share.

Right now, the stock price is $7.57 so it’s trading close to NCAV from when I first calculated it.

Friedman Stock Price Make Up

Whether it’s by luck or just coincidence, you can see that the NCAV is acting as a floor for this troubled yet well managed company.

It’s just a matter of keeping an eye on the NCAV each quarter to make sure that there is no sudden deterioration.

Why You Wouldn’t Buy a Net Net

Why You Shouldn’t Buy Net Nets

There are very real reasons for why you wouldn’t buy net nets though.

The main one is that any company trading at or below NCAV/NNWC is going through some serious troubles.

Here are some reasons companies become net nets.

Just lost their major customer who makes up 95% of sales

Management was embezzling money for years and cooking the books

Their main product is making CD’s

They have no operating business

The market doesn’t believe their new drug will ever get approved

and the list goes on

Definitely some scary reasons.

Actually, let’s face it.

But before I tell you the big net net no-no’s, please click on the image below to download the best investment checklist that will save you time and organize your thoughts.

They are garbage.

I’m sure you’ve walked into a store and saw a table or a small basket with items being liquidated.

Everything is so cheap.

But 99% of them are useless.

Why would you want an open pack of sliced cheese that is close to expiration for just 50c?

What are you going to do with that slow and outdated laptop with some keys missing?

That’s what net nets are like after all and it definitely doesn’t suit everybody.

It requires a certain type of personality to make net nets work.

The type of person who buys that pack of cheese, makes a nice sandwich and sells it to his friend for a few bucks and makes a profit.

Or the type of person who pulls the laptop apart and sells the parts for a nice profit.

Net nets are a big no no if you have the following traits:

Don’t want volatility

Want to hold something for as long as possible with very minimal turnover

Don’t like buying small caps

Don’t like analyzing OTC stocks

Want to stick to mainstream ideas

You have to look important to others

You want to brag that you found the next GOOG, TSLA, MSFT

And this is perfectly fine because being comfortable with where you place your money is very important.

Net Net Buying Checklist – 7 Simple Rules to Follow

But if you are not limited to large caps and don’t mind net nets, here’s a brief checklist you can follow to make sure you reduce your risk as much as possible.

1. Stay Within Circle of Competence

It’s a cliche but it’s true.

Although you only have to focus on the business itself, you are looking at a company that has a lot of troubles. So it’s easier to stick to what you know.

2. No Chinese stocks

Unless it’s Alibaba, most Chinese stocks are still very shady. Especially the smaller ones. High chance of fraud so why risk it. The idea is to buy cheap net nets that will lower risk.

Not to find ones that you think will go up by 1,000%.

3. Has a Valid Operating Business

Stay away from net nets where their business model is totally outdated as the value will erode.

A company could have a solid balance sheet, but if it’s main business is photo printing or backup data with CD’s, run away.

4. Low Cash Burn

Make sure the company has enough money to last for several years even if it keeps losing money.

Get the TTM FCF or last year numbers and divide it by how much money they have on the balance sheet.

Here’s the example with FRD again.

On the balance sheet, they have $10.8m in cash and the TTM FCF is a negative $5.4m.

And this is what the company confirmed in their last filing.

Notwithstanding the current market conditions, the Company believes its cash flows from operations and borrowing capability due to its strong balance sheet are adequate to fund its expected cash requirements for the next 24 months. – FY2015 Q1 10-Q

You can do the same thing with Cash from Operations and compare it with the FCF figure to see how much of a difference there is.

But stick with FCF if you can.

You can also use the average of the last 2 years, but it’s not a good idea to average more than 2 years because you don’t want to fool yourself into thinking that the situation is better than it is.

A low cash burn is your safety net.

A lot of the value is tied up in cash, so if the burn rate is high, you will be fighting against time as you see the NCAV value drop.

5. No Debt or Very Easily Manageable

Looking for safe net nets is key and debt is a killer for most small businesses.

When you consider that net nets are;

struggling with their main operating business

or losing money

the last thing you want is debt crushing them further.

6. No Insider Selling

I want to see insiders committed to saving the company, looking for ways to sell it or just extract value out of it.

Insider selling when the stock is at its lowest price point is a sign that management doesn’t care about anything other than filling up their pockets before the company rolls over dead.

7. Signs of Buybacks

The opposite of #6.

If management understands that the sticker price on their company is ridiculous, they can continue to buy up shares to increase the value of each share.

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